Back in 2004, early in my blogging career, I heard about a service that had just launched called Feedburner. It provided a number of useful services for a blog's RSS feed. So I went and signed up and AVC became one of the first users of the service. I immediately liked the service and the idea. So I contacted the founder/CEO Dick Costolo, who has gone onto bigger and better things. I told Dick that I was interested in making an investment in Feedburner. My friend Brad Feld was also talking to Dick about the same thing so we decided to do the investment together.

As part of our investment process, we do a bunch of fact gathering/checking work that is called Due Diligence in the vernacular of the VC business. So my partner Brad Burnham and I put together a list of leading blogs and online publishers who had popular RSS feeds at the time. I think there were a dozen or so publications on that list. It included Weblogs (Engadget), Gawker (Gawker), NY Times, and a bunch more. We know most everyone who ran those operations so we called them.

What we heard was surprising. Not one of them was willing to hand over their RSS feed to a third party for analytics and monetization. We were very surprised to hear that and thought a bit about it. But, we decided, we could not invest in something that the big publishers would not support. So regrettably, I called Dick and told him we had to pass and why. Brad Feld went ahead with the investment and Feedburner closed their round without USV.

About six months later I ran into Dick at an industry conference. We decided to grab lunch together and during lunch he said to me "you know those dozen publishers you called?" I said "yes, what about them?" He said "every single one of them is on Feedburner now."

I was pissed. How could that be? So I said to Dick, "Would you consider letting us into that last round we walked away from." He said "No, but I will let you invest at a 50% increase in price". We did that and became an investor in Feedburner. And that worked out well when Feedburner was sold to Google a few years later.

So what did I learn from this lesson? First, trust your gut. I was using Feedburner and knew it was a very useful service. I felt that others would see that too. They did, but it took some time. Second, I learned that a service can get traction with the little guys and in time, the big guys will come along. I have seen that happen quite a bit since then. And finally, I learned that you can do too much due diligence. It's important to talk to the market and hear what it is saying. But you have to balance that with other things; the quality of the team, the product, the user experience, etc. You cannot rely alone on due diligence, particularly early on in the development of a company and a market.

In the early days of Tumblr, I used to bug David Karp, the founder and CEO of the Company, about comments. Though I had hacked my tumblog with Disqus, I wanted to be able to comment on other tumblogs and the vast majority of them had no comments because Tumblr did not support them natively. I was fairly persistent in my argument.

But David held firm. He wanted Tumblr to be a positive place on the Internet. The entire design of the service was with that in mind. There were loves (upvotes) but no downvotes. If you wanted to talk about someone's post, you had to reblog it to your tumblog and then add whatever you wanted to say. David thought that would eliminate trolling.

Eventually, I gave up and moved on to pestering some other entrepreneur about something I thought they should do with their product. David kept building positivity into his product and today there are 106 million blogs with 50 billion posts on them collectively.

In hindsight, I think David was right and I was wrong. I wanted him to build something that felt more like Wordpress or Typepad (where I blog). He had something different in mind. And to David's credit, he had the courage of his convictions to follow his own instincts.

This is tricky territory for VCs and entrepreneurs. Because most of the time the entrepreneur will have a better feel for their product vision than the VC will. But there are times when what the entrepreneur is doing is not working and the VC will have to figure out how to get the entrepreneur to see that. I have learned to trust the entrepreneurs instincts until it is very clear I should not. Finding that line is art and not science and takes a lot of experience. And I still get it wrong from time to time.

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I woke up thinking about Morty this morning. I haven't seen or heard from him in over ten years. But Morty taught me one of the most important lessons about negotiating that I've ever learned.

Morty was Isaak's partner in Multex early on. They put up the initial money to get it started. Morty wasn't a venture guy. He was a real estate lawyer and sometime real estate investor. He was as conservative as you can get and never liked the startup/venture business. But he was Isaak's partner. And Isaak asked Morty to negotiate the term sheet for the seed round with me.

This was late 1992 and I'd been in the venture business for five years and was on my second or third deal on my own. I'd negotiated a bunch of term sheets by that point, but I'd never had a negotiation like the one I was in for with Morty. Actually I don't think I've ever had one as rough as that since.

Morty wasn't familiar with venture terms. They didn't make sense to him. So standing in an airport pay phone (before cell phones) I went line by line, term by term with Morty.

We got to redemption and he started in. "Why do you need this provision Fred?". I was getting tired of his non stop push back and blurted out "Because it's standard. We always get this provision. Always have, and always will".

That got Morty pissed. He shouted over the phone:

I don't give a f>>>k that you always get this provision. Doesn't mean shit to me. This deal will be the first time you don't get it if you don't explain why you need it.

That set me back on my heels and I weakly explained that if the deal goes sideways for years, we need some way to get out of the deal and redemption provides that path. I don't even remember if he bought that argument. But I do know that we had redemption in the Series A at Multex and pretty much every deal I had done at that time.

But the point Morty made rang true to me and I've lived by his rule ever since. I never ever say that a specific provision is "standard". Nothing is standard. You either need it or you don't. Explain why you need it and most of the time you'll get it or something like it as long as both sides really want to make a deal.

In the lull between Flatiron and Union Square Ventures, I made a few angel investments and the best one was in a company called TACODA that went on to become a Union Square Ventures portfolio company and in many ways directly led to the creation of Union Square Ventures. My partner Brad who I founded Union Square Ventures with had left the venture capital business temporarily and was involved in the creation of TACODA, having provided the initial seed capital to Dave Morgan, the founder of TACODA.

Dave had previously founded Real Media, one of the early ad server companies, and he had seen the need for better targeting of display ads on the Internet. His idea was to build a companion to an ad server that could collect behavioral data and target dispay ads to the people who actually wanted to see them. This became known as behavioral targeting. The intital business model was to sell the behavioral targeting engine to publishers who would then sell the behavioral segments to their agency customers.

The software cost between $10k a month and $20k a month and was sold as a SAAS service to publishers. TACODA closed a few big deals early on and got validation of the product and the market from that. But it got harder and harder to close these deals as publishers were wary of coming out of pocket big dollars on a new technology that they weren't sure would help them make more money.

After six or nine months of disappointing numbers, I recall a meeting with Dave where Brad pointed out that the team was "working too hard and not getting anywhere." Brad suggested that the company try a new business model in which it would operate the targeting engine in the cloud and sell the advertising in an ad network model and then share the revenue with the publishers. In effect, Brad proposed that we send the publishers checks instead of asking them to send us checks.

Dave saw the logic of Brad's arguments and slowly but surely pivoted the company into an ad network. And once the business model pivot was completed, revenue took off. In less than three years after the business model pivot, the company was doing north of $50mm in revenues and was bought by AOL for $275mm.

The moral of this story is sometimes you have the right product but the wrong business model. Fixing the business model can fix the company. It certainly did in the case of TACODA.

I have known Scott Heiferman since the late 90s. He was one of the early NYC web 1.0 entrepreneurs. We were quite friendly with Scott but we were not early investors in Meetup, the company Scott started right after 9/11. Scott and I were at an event together and when asked about something he replied that he viewed Meetup as "a twenty year project." He said that it would take at least twenty years for Meetup to achieve all that he wanted from it and possibly a lot longer. And that he was patient and committed to that timeline.

As we left the event, I turned to my partner Brad and said "we should invest in Meetup, Scott is the kind of entrepreneur that we like and respect." And eventually we did invest in Meetup and we have been investors in Meetup for almost six years now.

Meetup is in its second decade as a company and growing rapidly. Last night Meetup booked its hundred millionth RSVP. You can see the counter at the top of this page. That is one hundred million people who used the Internet to get off the Internet and go out and meet other people and talk about things they are passionate about. Now I realize that some of these hundred million people are the same people doing this again and again. But even so, a hundred million RSVPs is a big deal for a company that has been plugging away on this mission for more than a decade.

When you are at something for a decade or more, it can become a slog. It requires tenacity and persistence to keep pushing and innovating. In the past year Meetup has started growing faster than it has in quite a while. The chart below shows that:

Scott and his team are as passionate about the Meetup mission as they were when they started the company. They have a very long timeframe in their minds and they are executing against it. And they are winning with tenacity and persistence. Which is why we backed Meetup in the first place. Well done Meetup.

When something goes badly in your company, for many the initial instinct is to keep things under wraps as much as possible to avoid freaking everyone out. I would argue that it is better to acknowledge the crisis and use it to your advantage.

Change is hard to bring to an organization and a time of crisis is often a perfect time to make some changes that you have wanted to make for a while. It creates a perfect backdrop and context for doing that.

Maybe you are in the midst of a financial crisis brought on by a tough fundraising environment. Maybe you are experiencing some management turmoil. Maybe you've lost your largest customer. Maybe you are getting pummeled by bad press. It really doesn't matter what is the cause of the crisis, but all of the above will work well.

I have seen a portfolio company react to a financing crisis react by making important and overdue changes to its business model and organization. The financing crisis ended and the company emerged in a much stronger place.

I have seen an entrepreneur react to the loss of several important team members by shuffling up the organization, pivoting the product roadmap, and operating with a much leaner team. The company recovered from the loss of the key team members, launched a new product very successfully, and got onto a path to profitability.

There are a lot of these stories to tell. Because crisis is what brings clarity and focus. You get punched in the gut, you get back up, and you take care of business.

So if you are in the middle of a crisis in your company right now, think hard about using it as an opportunity to make some changes. There is never a better time.

The paper starts out with this observation:

When a company launches a new product, the temptation is to immediately ramp up sales force capacity to acquire customers as quickly as possible. Yet in our 25 years of experience with start-ups and new-product introductions, we’ve found that hiring a full sales force too fast just leads the company to burn through cash and fail to meet revenue expectations. Before it can sell the product efficiently, the entire organization needs to learn how customers will acquire and use it, a process we call the sales learning curve.

Not only does the organization need to learn how customers will acquire and use the product, it is also true that the product itself may not be exactly what the market wants. In other words, launching a product is not the same thing as acheiving product market fit. The organization may need another six months, a year, or even longer to get to prodcut market fit.

One of the things I have observed over the years is that a hard charging sales oriented founder/CEO can often hide the defects in a product. Because the founder is so capable of convincing the market to adopt/purchase the product, the company can get revenue traction with a product that is not really right. And that can hide all sorts of problems.

I am thinking of a company, which will remain nameless, that ended up selling itself in a fire sale. The company had strong revenue traction early on, and with that traction raised a big round of financing, which then led to a big increase in headcount, for both sales force and product/engineering, and then faced a lot of churn in its customer base. That led to a very difficult period where the company worked hard to iterate on the product while maintaining this high burn rate. In the end the burn rate killed the company and in my opinion it never really found product market fit.

Like Mark Leslie advises in The Sales Learning Curve, it is dangerous to ramp up headcount and burn until you are certain that you have the right product and the right people and processes in the organization to support the product. And early revenue traction, often driven by a passionate founder, can be a nasty head fake. Try not to fall for it.

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The Return Of MBA Mondays: I am going to try a new take on MBA Mondays, suggested by one of you in the comments last monday. I am no longer going to write posts on specific topics as I was doing. I am going to take a page out of the "case method" and tell stories that have a lesson, hopefully based on real situations that I have lived through. I don't know how well this will work, but I am going to give it a try.

I am not sure where to go from here. I am spent and don't feel like I have any more MBA Mondays material. I used to look forward to writing these posts every Monday. Now I dread it.

So I am suspending this feature for now. Taking a sabbatical. I can't promise they will be back. But I am not sure they are over either. Time will tell.

Gaming is interesting because there are a number of revenue options that game developers can choose from when thinking about how to make money from their game. The hackpad lists the following:

There is still a sizeable business in selling a version of the game to the game player. That's how the console game (xbox, etc) market works. It is also how downloadable games market works. And there is a vibrant market in mobile games that you have to pay for to play.

But the games market has been moving to newer models in recent years. In app upgrades is certainly one of the more important revenue models. Many of the most popular mobile games are free to play but offer in app upgrades to get more game elements or simply to eliminate the ads. This is an example of the freemium business model in action.

Advertising is another important revenue model. For many web based games, advertising is the dominant form of revenue. On mobile, advertising supports the free offer and the elimination of advertising is often the value proposition for the in app upgrade.

The revenue model that is mostly (but not totally) unique to gaming is virtual goods. Virtual goods (like a tractor in Farmville) allow the player to have more capability in the game and they can be earned over time but are often purchased to enhance game play. This revenue model was inititally created in the asian gaming market but has been adopted by game developers all over the world.

I have been waiting for non gaming web and mobile services to adopt the virtual goods model but have yet to see anything that feels like it is working really well. Virtual goods is another excellent implementation of the freemium approach to business model.

There are game developers who use all of these models at the same time. They might sell their game on certain platforms, they might offer a free ad supported version on mobile with in app upgrades and virtual goods. In many ways, I think the gaming market is the most sophisticated about revenue models of all the sectors in web and mobile. That may stem from the fact that most games have a finite life and so the developer has to extract real revenue quickly to get a return on the investment they have made in developing the game. I think there is a lot that the rest of the web and mobile services world can learn from the gaming market.

Here is what we filled out for mobile in the revenue model hackpad:

Mobile offers revenue opportunities that the web does not for a few reasons. First, the downloadable app/app store model makes selling your software much easier on mobile than it is on the web. In 2012, almost $7bn of apps were sold in the iOS and Android app stores. Most of these purchases are being made as in app upgrades instead of initial purchases.

But as huge as app sales are, including in app purchases, I believe this will be the smallest of the big three mobile revenue models over time (app purchases, advertising, and transactions).

The mobile advertising market was estimated at around $3bn in 2012 but it is growing twice as fast as app purchases and is projected by Gartner to be over $20bn by 2015, a 90% annual compound growth rate (that compares to app purchases which are growing at about 30% per year).

I do not believe that we have yet cracked the code on mobile advertising. Mobile native approaches like Twitter's promoted tweets show the way. Interruption and "display" models aren't likely to work in mobile so we will need ad formats and solutions that are truly native in the mobile app and browser. The market is quickly innovating and I believe we will see a number of interesting models emerge this year which will cause the mobile ad market to grow quickly.

But as attractive as selling apps and running ads on them is, I believe the biggest and most attractive model in mobile is the transaction. Slowly but surely, our phone is becoming our wallet. And I don't mean wallet in the way that Google and PayPal think. I don't think we will necessarily have a mobile wallet. I think the apps on the phones will just have native transaction capability in them.

I have a friend who recently moved from NYC to SF and was back in NYC for a week of meetings. He told me he kept accidentally getting out of cabs without paying while he was in NYC. Using Uber in SF had trained him that once he had booked the ride on his phone, that was all he needed to do. Soon hopefully we will all be doing that with our Hailo app in NYC.

But that is just an example. Imagine if you could both checkin and checkout on your Foursquare app? Imagine if you could just walk into a movie or an airplane just using your phone (you can!). All of these things are possible without mobile wallets. The phone is our mobile wallet.

So I think transactions will be the biggest and most native form of monetization on mobile over time. That doesn't mean that you can't build a good business doing in app upgrades and mobile advertising. But it does mean that transactional networks on mobile is the biggest opportuntity in mobile that I see.

Next week, we will talk about gaming and then we will wrap this series on revenue models.

So it makes sense that collecting and publishing data is one of the primary business models on the Internet. Here are some of the examples that you all created on the revenue model hackpad:

I like to think of data businesses in two categories; businesses that aggregate and then publish data and businesses that generate their own proprietary data by virtue of the service they provide on the internet.

Most of the companies listed in the data section of the revenue model hackpad are businesses that aggregate data from others and sell it. These can be good businesses but they are rarely great businesses.

Google is an example of a business that generates its own proprietary data by virtue of the service they provide. Google doesn't monetize with a data revenue model, they monetize with advertising that is targeted based on the data they generate. But in many ways, Google is a data business. Data is the secret sauce of their business and they have invested heavily in data science to maximize the value of their data.

Facebook and Twitter are rapidly becoming data businesses like Google. They collect a ton of data about users and what they think about and care about by virtue of providing a free and valuable service on the Internet. And that allows them to improve their services, make them smarter, and to target advertising to their users.

Going back to the aggregation model, if you are going to pursue this approach, try to figure out how to make your data as proprietary as possible. Anyone can aggregate so you run the risk of commodification in the aggregation game. If you can create some sort of proprietary advantage, either through exclusive access to the data or through some sort of refinement of the data using your own insights and analytics, that leads to a better aggregation type business.

Most data businesses are subscription based, but data can also be sold on a transactional basis. Transactional models are easy to sell when you are just getting going, but subscription models work better over the long run.

Many data businesses use APIs to make it easy for their customers to get data into their own systems. This is a good idea because it makes it harder for customers to leave if your data is part of their systems. If you can make your data part of a broad ecosystem, that is a good thing.

Selling data is a good way to build a business on the Internet but if you can figure out how to leverage proprietary data produced by your service to make your service even better, that often turns out to be an even better "data business".

Here are some of the ways licensing can be used to build a business:

The first five items in that list are related to the software business and reflect the dominant business model for software before the internet came along. Software used to be sold (licensed) with maintenance as the recurring revenue item. The internet has largely changed that with software moving to a subscription model (SAAS) as we discussed in the subscription post. Software is still sold with a license, in fact the SAAS model doesn't change the provision of a license, but the idea that you will pay up front for a license has largely gone away in favor of the subscription.

An important and growing form of license is the open source license. There are a number of variants on the open source license but the basic idea is the licensor makes a license of the software avaialable for free for anyone to use, modify, and share. The benefits of this model is that the software is maintained and improved by a group of developers working together with no economic model around their collaboration.

The last two items are forms of intellectual property licensing where an owner of a patent or a brand will license it to someone else to use in return for a monetary payment. These revenue models can work online but they don't take advantage of the scalability of the internet. In fact intellectual property and the internet are in many ways in tension with each other.

The only form of licensing that USV is actively investing around is the open source model. We think open source is an attractive form of licensing that creates network effects in the developer and user community and we have had success investing in the open source model.

That said, licensing is probably the least interesting business model to me of all the ones we are covering in this series. It is possible that entrepreneurs will invent new ways of licensing that take advantage of the scale and reach of the global internet, in the way that open source does, and that could produce some interesting opportunities.

If you look at the Revenue Model Hackpad, you will see that there are a number of different kinds of transaction processing businesses:

The first four examples in the hackpad are related to credit card processing, the next three are related to banking transactions, then there is fulfillment which is physical logistics, then the next three relate to the world of telephony, and the last one is related to internet and mobile platforms.

So you can see that transaction processing is a business model that can be applied to a number of different types of transactions. And certainly our revenue model hackpad is not comprehensive. So I am sure there are many other forms of transaction processing businesses in the online world.

The thing that all of these forms of transaction processing have in common is the processor handles a transaction that was generated by another product or service and provides some form of completion service and charges a fee for doing so. That could be processing a credit card transaction, handling a banking transaction, shipping something to someone, completing a call originated on another network, or distributing a third party app on an internet or mobile platform.

For financial transactions, the fees are generally small, typically in the 2-4% range. For banking transactions, the fees are often much smaller than that because the credit and fraud risks are lower.  For logistics (shipping and handling), the fees vary but relate to the costs of providing the service. For telephony, the fees are generally expressed per minute or per message and are generally low but can be high in certain markets. Platform distribution fees are the outlier as they are often very significant, Apple charges a 30% cut in its app store.

For the most part, the transaction processing business model is all about scale. You process billions of transactions and take a few percent of the total transaction value. PayPal processed $145bn of transactions in 2012 and generated $5.6bn in revenue. Out of that $5.6bn, PayPal has to cover all its costs including processing fees to other transaction processors, customer service, fraud prevention, fraud losses, technology and development, and several others. I am certain that PayPal makes a very nice profit off of that $5.6bn of revenue but it is probably on the order of $1-2bn, which is in the range of 1% of the total transaction volume. This is a business model of pennies on the dollar, literally.

One of the challenges of this business model is that the fixed costs required to process transcations can be significant and you will operate a loss until you can get to scale. You can see that by looking at how much capital Square has raised to date. Crunchbase has it at $341mm. Now Square is one of the most exciting new companies created in the past five years and is executing incredibly well. But it has taken hundreds of millions of dollars to get where it is today. That's what I am talking about. You had better be prepared to fund the costs of ramping to scale if you want to be in this kind of business.

In general, I like these kinds of businesses a lot once they reach scale, but am cognizant of the costs of building them. They are not for the faint of heart.

If there is one thing I have learned investing in Internet businesses over the years it is to pay attention to things you can't do without the Internet. And that describes peer to peer pretty well. Like the Internet, a peer network empowers the edges and devalues the middle. I like peer networks very much.

If you look at the revenue model hackpad, you will see a list of some interesting peer network businesses, including our portfolio companies Lending Club and Etsy. They all take a similar approach to revenue generation. They connect one or more people together to conduct a transaction and take a fee for doing so. In Etsy's case the transaction fee is 3.5%. In Lending Club's case, the fee is generally 4% to the borrower and 1% to the lender. In Kickstarter's case, the fee is 5% to the project creator if the project is successful.

But there are ways to generate revenue outside of the transaction fee in peer networks. Etsy is a great example. In addition to the 3.5% transaction fee, they charge a 20cent listing fee, a payment fee for payments processed on their direct checkout service, and they have an advertising marketplace so sellers can promote their items on Etsy. It is possible to sell on Etsy and share less than 5% of your revenue with Etsy. It is also possible to sell on Etsy and share more than 10% of your revenue with Etsy. It all depends on how many of their services you are using to run your business.

I like this approach very much. I think the basic fee for participating as a seller in a peer network should be as low as possible. This allows the marketplace to develop as much liquidity as possible. Increasing transaction fees will push sellers out of your market into other ones. The better approach to increasing revenues is value added services that sellers can avail themselves of but are not required to. If these services allow sellers to sell more or if they make selling easier, sellers will adopt them and your take rate can ultimately be much larger than your transaction fee.

The purpose of the revenue model in a peer network should be two fold. First it should incent as many participants in the peer network as possible (ie the lower fees the better). Second, it should produce enough revenue so that the business will produce significant profits at scale.

The thing about peer networks is most of the value is created by the participants in the network. The business doesn't do that much. It provides the basic infrastructure so that the market can work. It provides trust and safety and governance. And it provides customer service and support. The participants in the network do most everything else. That means these businesses can and should operate very efficiently at scale.

Craigslist is a good example of a peer network leveraging the power of the model. I have no idea how much revenue Craigslist makes and how many employees they have. But I would not be surprised if it were a $200mm annual revenue business with $150mm or more of annual profits. And yet it is capturing a tiny amount of the economics in its peer network. It should easily be the case that billions of dollars a year are transacted because of Craigslist. So what you see is a huge amount of transactional volume, a relatively small percentage of which is captured in terms of revenue, but a huge percentage of the revenue that is collected drops to the bottom line. That is what a peer network business model should look like.

And it scales really well. Because so much of what a traditional business would do is being done by the peers on the network instead of the company. Compare an online retailer with Etsy. An online retailer needs to have buyers and merchandisers. It needs to have inventory and warehouses. It needs to ship and track. It needs to spend a large percentage of revenues on marketing, customer acquisition and retention. Etsy doesn't spend much money on those things. Their sellers do. And as a result, their sellers keep more than 90% of the value of the transaction as opposed to giving up 50% as a wholesaler.

So peer networks are powerful businesses that when constructed well have great defensibility and staying power. The key is keeping the take rate as low as possible and incenting participants to transact with you instead of someone else. If you can do that, you can build a large and sustainable business with this model.

The emergence of the subscription model has made the software business better. In the old upfront license fee model, software companies would trade at 2-4x revenues. Now they trade at 6-8x revenues. That reflects the recurring, almost annuity nature of the subscription model.

Software is not the only technology oriented business that utilizes a subscription revenue model. Content has also moved from an upfront fee (buy an song or a movie on iTunes) to a subscription model (a monthly fee for Spotify, Rdio, Netflix, or Hulu).

And infrastructure is now also sold on a subscription model. Amazon Web Services (AWS) is a great example of this. Need a server? You can provision it for yourself in the cloud and pay a monthly subscription for it. Same with storage and a host of other infrastructure services.

The emergence of the subscription model for software, digital content, and infrastructure has led entrepreneurs to offer all of these in limited form for free with a paid upgrade to a monthly or annual subscription. The term for that form of subscription is freemium, a term that was invented by Jarid Lukin in the comments on this blog in March 2006.

Subcriptions can be paid monthly or annually in advance. Many companies opt for the latter model and that works really well because it creates a favorable cash flow dynamic in the business. Cash comes in before most of the revenue is recognized, leading to a healthy and predictable business model. In addition, the subscription business model allows a company to book most of the revenue for the year in advance. Companies with subscription based revenue models often have great visibility into the next twelve months of revenues, a feature which makes for a great public company.

The big gotcha in subscription revenue models is churn. If you churn more than 10% of your customers every year, subscriptions can be a challenging model. You need to grow new customers at 10% just to stay even. I encourage our portfolio companies that utilize a subscription model to be very active at managing customer satisfaction and to actively monitor the customer's usage of the software or service to identify customers with high churn potential. This kind of data can be automated and leveraged to proactively manage problem accounts and reduce churn.

The first several years of a subscription based business will typically require a fair bit of funding because the revenues come in over time instead of up front. But once a subscription business reaches scale, it has very favorable cash flow dynamics, as mentioned above. For these reasons, subscription based businesses are good businessed to raise capital for and investors generally find them attractive to invest in.

In many ways, the subscription business model is the most attractive of the "big three" (advertising, commerce, and subscriptions), all of which we have now covered in this MBA Mondays series on business models. Subscriptions are more predictable and reliable and as a result create more investor confidence leading to higher multiples and more valuable businesses. Of course that is not universally true of all businesses, but I have found it to be generally true over long periods of time and many different businesses.

So as a placeholder, I am re-running the video of the Skillshare class I did on Employee Equity in April of this year. If you haven't seen it, I think it's a good primer on how entrepreneurs should think about managing the employee equity in their companies.

Retailing is by far the largest component of the online commerce market. Retailing is buying a product at wholesale and selling it to the customer at a markup. Retailing involves inventory. You stock up on inventory so you can provide the goods quickly to the customer.

Amazon is the world's largest online retailer. Amazon's revenues in the past four quarters were approximately $55bn. Clearly some of that revenue is non-retailing but let's assume their retailing revenues are about $50bn annually. They are roughly 10% of the global ecommerce market.

Retailing is a tough business. The difference between what you buy the product for at wholesale and sell it at retail is called your gross margin. Amazon's gross margin ranges between 20% and 25% depending on what time of year it is. The holiday quarter brings the lowest gross margins because retail makes up a larger perecent of revenues. At Amazon's size, a 25% gross margin turns into a lot of money. But a smaller online retailer can really struggle at these margins. Let's imagine a retailer of bicycles on the Internet does $50mm in revenues. That sounds great. But that means that only $10mm to $12mm a year actually stays in the business. The rest goes out to the bicycle manufacturers. And then the retailer has to pay for the website, the traffic acquisition, the staff to operate the business and a lot more. Pre-tax margins for online retailers will typically be in the sub 10% range, often less than 5%. To put that in context, the bicycle online retailer that generates $50mm in sales will keep a couple million pre-tax at the end of the year. It's a business for sure but not an easy one.

The reason that online retailing is so tough is that it is hard to differentiate one retailer from another. You want a new mountain bike? Go to Google and see what's out there.

Retailing has always relied on location to provide some margin protection. There is no "location" on the Internet other than SEO. So gross margins online are going to be lower than they are in the real world. And on top of that, you have the capital outlays required to stock up on inventory and the markdown costs associated with getting out of unsold inventory. And then there are the shipping costs which increase the price to the customer unless you are willing to eat them.

I have never invested in online retailing. I don't like the economics of this business even though it is a huge market.

Beyond retailing, there are a number of other ways to do commerce on the Internet. The next is marketplaces. Marketplaces are places where buyers and sellers come together to transact. Marketplaces have always existed in the offline world. It turns out that the Internet is a terrific place to create marketplaces. And they have much better economics. There is no gross margin for the marketplace operator, just a transaction fee. There is no inventory. There are no shipping costs. All of those costs are born by the seller. I have invested in quite a few online marketplaces. I love the economics of these businesses. I plan to write an entire post in this series on peer to peer business models and marketplaces will be a large component of that post, so I will move on.

One way to get past the gross margin and differentiation problem on the Internet is to make all the goods you sell yourself. This is called "vertically integrated retailing" and it is a growing trend in online commerce. A great example of this model is Warby Parker which makes and sells a line of fashion eyeglasses. Warby Parker has no stores (at least they didn't when they started out). The Internet is their store. Vertically integtrated retailing has better economics because your products aren't commoditized by Google and the other search engines. Customers seeking your products must come to your website to purchase them. But these businesses have other issues. Building a brand is tough, particularly from a standing start. Manufacturing, most likely overseas, can be a challenge. The capital costs remain high because you still need to stock up on inventory. And you can face markdowns if your SKUs go out of style. Although I like this model much better than straight up retailing, I have never invested in this model either. The Gotham Gal has made a few investments in this sector though.

Another flavor of retailing is flash sales and daily deals. This is not a new concept on the Internet. There have always been clearance sales in the retailing world. But the Internet brings new tools to drive immediacy and rapid transactions. A french startup called Vente-Privee brought the concept of the flash sale to the Internet over ten years ago and it has been adopted widely across the globe, particularly in the past five years. Flash sales have better economics than traditional retailing. They are often acquiring the product at discounted prices. The inventory costs are lower because they blow out of the product quickly. And there is no competing for the buyer's loyalty on Google every day. Flash sales sites leverage mailing lists to bring their customers back again and again. The issue with flash sales is customer burn out. It is difficult to maintain a vibrant flash sale business over many years.

Auctions are another way to drive commerce online. eBay is the canonical company in this category. The nice thing about auctions is they leverage a set time frame to drive toward a clearing price. It is game of sorts and can be quite addicting and engaging. Auctions work particularly well in marketplaces where there are unique items to be bought and sold. eBay's gradual adoption of the "buy it now" model suggests that there are limits to the auciton model at scale and that consumers prefer a straight up retail model because of its simplicity. I suspect that auctions make up a substantially smaller percentage of online commerce revenues than they did ten years ago.

The revenue model hackpad includes a number of other forms of online commerce which I am not going to dive into in this post. If you have questions about any of them, I would be happy to take them in the comments.

In summary, commerce represents the largest and most common online revenue model. But it is not an easy one to execute profitably. It lends itself to commoditization and margin compression in most cases and the economies go to scale players like Amazon, eBay, and Walmart. While there has been substantial venture capital investment in this sector, particularly in recent years, it is not a sector that I like very much, other than marketplaces which to me are really peer to peer businesses. I will cover them more in a few weeks.

It is true that the vast majority of consumer web apps have been and continue to be monetized with advertising. On mobile that is less true, but becoming more true every day.

There are all sorts of ways to generate advertising revenue online. Here are the entries under the advertising category in our revenue model hackpad:

This list is most certainly not exhaustive but it does cover the most common advertising approaches and you can see how many there are on the Internet. There has been a lot of innovation in this sector in the past 18 years since the first banner ads were created and sold.

The famous Luma Partners slide shows just how complex the online ad market has become over time.

And this market map is by no means exhaustive either. Online advertising is a big and complicated business.

I would break up advertising into two big buckets; ads that are sold and ads that are bought. The first is a relationship business, requires a direct salesforce or a salesforce that you can tap into, and will bring a higher revenue per impression in most cases. The latter is a data business, automated by machines and software, is a volume game and will bring a lower revenue per impression in most cases. Much of the online advertising market is moving inexorably toward the latter category, for good and bad.

The reaction to this move away from high value "brand" advertising to commoditized and programmatic advertising is native ad formats and advertising models. I have written about native advertising at AVC before and am a big fan of this approach. Examples of native advertising are promoted tweets on twitter and radar and spotlight on tumblr. In both examples, the ad unit is the same atomic unit of content as the users create in the service. I think we will see more and more of this as the value of the impression is driven lower and lower in the programmatic model.

When you think about an advertising revenue model, you need to think about one of two things; scale or niche. Scale means hundreds of millions of impressions a month or more. Niche means a valuable audience that advertisers will pay a premium for. But even if you are going for the niche approach, you will still need to have a lot of impressions. Here is why:

Advertising is sold many ways, including:

CPM: Cost per thousand impressions

CPE:  Cost per engagement

CPA:  Cost per acquisition

CPC:  Cost per click

Sponsorship:  Fixed cost for a fixed program

[thanks to Darren for that list. I took it directly from his email to me]

With the possible exception of Sponsorship, all of these methods will converge to the same number. For example if you sell a click for $1/click, and one out of every hundred page views turns into a click then you are selling a page view for $1/100 (1 cent), and that turns into a $10 CPM (10/1000).

CPMs have been in decline for years on the Internet. That's because the Internet keeps on creating more and more inventory. There is no scarcity. And as a result the supply/demand clearing price just keeps going lower and lower. Ten years ago, a $10 CPM was acheivable. Today, you will be lucky to get a $1 CPM. A $1 CPM means that 10 million impressions will generate $10,000. That's enough revenue to sustain a one or possibly two person business but not much more. You will need at least 100 million impressions and ideally more than 1bn impressions per month to have an interesting advertising supported business at scale. 1bn impressions is a lot of users using your service a lot.

Niche will work at slightly less scale. If you have a unique and valuable audience, you might be able to get a $5 to $10 CPM. So you will need 100 million impressions per month instead of 1bn impressions. That's still a lot of super valuable users engaging a lot.

If you are going with a scale model and you have a service that has that level of inventory to sell, then you have the choice of building a sales force inside your company or using a third party to sell your inventory. You don't need just one third party. You can use many of them. That's where the Luma slide (above) comes into effect. There is an entire industry built to take the inventory you give to a third party and put it through endless machines and algorithms before it is shown to an end user. I will not get into this in more detail here but Darren's slide deck, which I linked to above, has some good information on that. When you use a third party to sell your advertising you can give away anywhere from 50% of ad revenue to 20% of ad revenue. Most commonly it is somewhere in between.

If you are going with the niche or native approach, you will need your own sales force and you will need to hire a leader for that sales force (a VP Sales or Chief Revenue Officer) who can build and lead that team. The sales leader is a critical hire. There are people who do this for a living, who really understand how to put a team together and generate advertising revenue predictably and reliably, and they are highly compensated and are worth every penny. Do not skimp on this if you are building your own sales force. You may choose to build your own sales force if you are going with a scale model, but you don't need to do that right away.

In the interest of keeping this post a reasonable length, I will end here. I highly recommend diving into the comments where we will discuss and debate this post. I will conclude by saying that an advertising model is a viable revenue model option if you are building a service that has a lot of scale. But if you don't have millions of users a month, you should think hard before going in this direction. There is a limited amount of ad dollars out there (except CPA budgets which are in theory infinite) and more and more services trying to tap into them every day which is why advertising rates on the Internet seem to be in permanent and systemic decline.

I am going to spend the next couple months talking about revenue models for online businesses. We've started off this series by crowdsourcing a list of the various business models that online businesses use. I will use that list as an outline for this series:

Here is the outline:

- Advertising - the service is free to use, marketers pay to reach your users via advertising

- Commerce - sell something to your users, keep some or all of the proceeds

- Subscription - charge your users monhtly or annually for the opportunity to use your service

- Peer to Peer - connect people together in a network, take a small piece of the activity that ensues

- Transaction Processing - settle transactions and take a small piece of the transaction for doing so

- Licensing - charge users once upfront for the opportunity to use your technology

- Data - sell the data your service generates

- Mobile - Mobile is not a revenue model, but we will discuss how mobile presents some unique challenges and opportunities for monetization

- Gaming - Gaming is not a revenue model, but we will discuss how gaming presents some unique challenges and opportunities for monetization

Of course these categories are not mutually exclusive. Many web/mobile services will use multiple revenue models. Freemium, for example is a combination of advertising and subscription.

I will kick off this series by making an important point about focus. I strongly believe that entrepreneurs should pick one revenue model to start with and focus 100% on making that work before rolling out another one. It is very hard to execute two or more revenue models at the same time. Better to nail the first one before rolling out the second.

I am a fan of starting with the most native and easiest to execute revenue model first. Ideally it will be one that improves the user experience or at least in no way harms it.

I am looking forward to writing this series. We'll start next week with advertising.

What happened is I am using a product, hackpad, that I don't really know how to use correctly. I am learning how to use it in real-time. Which is how I learn to use everything. Screw the manual. Just turn it on and get going. That can work, but it results in fails like we had yesterday. The truth is I still don't know exactly what I am doing with this product, but I am figuring it out.

The "final version" is now fully public but locked down for moderation. Whatever that means. I think it means is we can continue to edit this "final version" but I get to approve all edits.

Anyway, here's a link to the final version. There were some edits to the initial version yesterday that I like a lot. The transaction processing section was re-organized in a nice way. And a few more revenue models were listed. I will work to merge the two but don't have time to do that this morning.

Again, I want to thank everyone who has been working on this list. Crowdsourcing information is messy but together we have built something that is way better than I could do on my own.

So what edits did I make to the wide open hackpad? Well first, I tried to clean up the examples and make them as definitive as I could. The more well known a company/service is, the better example it is. I also took out many of the multiple examples. I think one is generally sufficient. I also took out the revenue models I thought were duplicative or slight variants of other revenue models. And there were a number of sections at the end that I would call "business models" as opposed to revenue models. So I took them out. Finally, there were a few entrepreneurs who were using this hackpad as a way to promote their companies. In effect, they were spamming the hackpad. I took out everything that felt like spam to me.

We are left with nine categories:

I think six of them are truly definitive revenue model categories (advertising, commerce, subscription, transactions, licensing, and data). The other three (peer to peer, mobile, and gaming) could be folded into the first six since they mostly map to existing models (mobile ads are ads). But these three categoris are unique in many ways and so I felt like leaving them in even though it's not as clean this way.

The "final" hackpad still needs work. There are some entries that are missing examples. I noted them with (??). There also may still be important or emerging business models we are missing. If you would like an invite to help fix the final version, please leave a comment to this post and I will invite you if I think your edit is useful.

My hope is by next week, we will have a truly definitive list of mobile and web revenue models and then I can use the list as a template for the MBA Mondays series on Revenue Models. Thanks for everyone's help on this.

I've created a hackpad that we will use to do this assignment. I've filled in a few of the most obvious revenue models and have started grouping them into the big categories (advertising, commerce, subscriptions). There are certainly more revenue models and additional big categories that aren't on the list yet. So please go take a look and add anything that you think is missing.

I will publish the comprehensive list next monday and use that to kick off this series.

The Disqus thread from that post in late April are full of suggestions so you might wade into them and see which suggestions interest you most. Or simply leave a comment with a topic you'd like to see me do a series on.

In my first post for the Sustainability class, I wrote:

Clay Christensen talks about this kind of thing all the time. Big company executives are asked to calculate an return on investment (ROI) on the investments they want to make. If the ROI isn't greater than some minimum hurdle, the company doesn't make the investment. And so along comes a smaller competitor who makes the investment and they eat the big company's lunch.

ROI is not the right framework for companies to evaluate investments. ROI is for the wall street folks. They will use it to decide if they want to invest in your company. But when you make investment decisions in your company, don't use the tools that wall street uses. Use the tools that animals use. Survival instincts. What will it take to ensure that your company is around in ten years, fifty years, 100 years? That's how to think if you want to stay in business.

And then the man himself, Clay Christensen, went and wrote a post for the NY Times yesterday which I highlighted in yesterday's What I Am Reading post. Clay wrote:

So we taught our students how to magnify every dollar put into a company, to get the most revenue and profit per dollar of capital deployed. To measure the efficiency of doing this, we redefined profit not as dollars, yen or renminbi, but as ratios like RONA (return on net assets), ROCE (return on capital employed) and I.R.R. (internal rate of return).

Since this is called MBA Mondays and we are supposedly teaching a MBA style curriculum, I want to emphasize this point. Do not use Wall Street tools to evaluate investment decisions in your companies. Use the tools that animals use. Survival instincts. What will it take to ensure that your company is around in ten years, fifty years, 100 years? That's how to think if you want to stay in business forever.

But Clay's post for the NY Times yesterday makes a broader point. If the folks who allocate capital in our society - venture capitalists, hedge fund managers, mutual fund managers, etc - are using IRR, ROCE, RONA, then they are going to allocate capital to companies that are making efficiency oriented investments, not empowering investments. And our society will continue to be awash in capital with no game changing  empowering investments that create new industries.

Clay suggests that we measure our returns in "dollars in dollars out" and forget about time, " profit as dollars, yen or renminbi". That's they way I was taught the venture capital business back in the 80s. Cash on cash, dollars in dollars out. That's what matters. If it takes a decade or more, who cares? The slow capital approach.

So if MBA Mondays is a school of business, then I hereby outlaw IRR, RONA, ROCE, from our lips. We aren't going to teach those tools and we aren't going to talk about them either. We are going to talk about making money the old fashioned way. In gobs and gobs, but slowly over time, with our survival instincts fully engaged. Let's hope others do the same.

I need the real-time feedback from the students in the class. I need to see if folks are getting what I am saying or if eyes are glazing over. I need to know if I need to take another tack on the material before moving on. And I don't get that with a massively open online approach.

So my next class is going to combine the in person dynamic with the power of a massively online approach. The best thing to come from the hybrid class model is the idea of using google hangouts/youtube to broadcast the class to everyone. I am going to do that from now on.

I also like the idea of teaching a four part class with a blog post each week. I can build on that model too.

I am less happy with the discussions on Skillshare and that they did not tie into the discussions that happened on AVC. I need to figure out how to make all of that work better. It's obvious that a teacher (me) can't give real time feedback to 2,731 students. And I think leveraging the students to give feedback to each other (the disqus model), is right. So it's worth working on this model to perfect it.

I want to thank Michael from Skillshare for prompting me to write about Sustainability this month. As I said in my first blog post on the topic, I think Sustainability is a great model for business owners and leaders to take in thinking about the highest objectives of the company. If I have contributed anything to the way business leaders think about Sustainability, then I have accomplished my goals with this class.

I am going to postpone my final office hours which were scheduled for this evening at 6pm eastern time. Hurricane Sandy looks to be coming through NYC at that time and I don't know what that may cause me and my family to be doing at that time. We live right on the Hudson, at the border of Zone A. So I've got a few things on my mind today that fit right into this Sustainability theme. I will report back on a new date and time for my final office hours.

Stay safe everyone on the east coast today. Let's hope the hype is overblown. And let's prepare as if it isn't.

I will not do office hours this evening but I will do one final office hours next Monday, Oct 29th, from 6pm to 6:30pm. The link to attend that office hours is here.

For this final post, I want to focus on the Business Model Canvas and how to think about sustainability in the context of creating your business model. In order to talk about that, I went ahead and created a Business Model Canvas of my own using bmfiddle.com.

My Business Model Canvas is for a Bitcoin Bank.

If you think about banks in the real world, they are high cost affairs, with huge fixed costs including large branch networks. I am always shocked by how many bank branches I pass in a five to six block walk in NYC. The way these banks sustain these high costs is with large fees for depositors and high spreads between their cost of funds and the interest rates they charge borrowers.

So in thinking about how to create a sustainable Bitcoin Bank, I focused on a few key things:

1) keep the operating costs super low except in areas where there is a unique and important consumer value proposition

2) make it easy to access the bank and your balances within the context of low operating costs

3) keep the fees charged to customers as low as possible

4) allow third parties to build busineses on top of our business

The result is a super simple business model. My Bitcoin Bank would charge a very low monthly fee per Bitcoin deposited and nothing else other than pass alongs for any costs incurred in moving bitcoins in and out of the bank on behalf of our customers. We would not have any branches. We would operate via simple, easy to use mobile and web interfaces. We would keep our operating costs super low with the exception of one area where we would make a large and ongoing investment - in hiring and retaining a top notch and super experienced security team. We would allow third parties to create related businesses on top of our API. Services like lending, investing, etc would not be provided by our bank but by third parties who access our customers via our API.

I believe this business would be highly sustainable because it would focus on one very simple value proposition - security. And in return it would charge the lowest fees possible in order to make and sustain a profit. It would make it very difficult for others to price lower fees for storage and security. And it would benefit from the ecosystem of third party value added service providers operating on top of its API.

Here are some decisions I made in order to increase the sustainability of the business:

1) A focus on very low fees to our customers so that it will be difficult for competitors to undercut our offering.

2) A decision to focus on only one thing, security, and allow others to build additional services for our customers. This allows us to be best in class at the one thing we choose to do and it means our customers can choose to pay for additional services or not, and always on their own terms.

3) A cost model that keeps operating costs as low as possible in all areas other than security, which is our key consumer value proposition.

So when you are finalizing your Business Model Canvas for your final project for this course, think about what your key value proposition is and who is your primary customer and focus on that. And think about what you can do in your revenue model to make it so that it will be hard for others to come in and undercut you. And think about your cost model and how to keep it as low as possible while allowing your company to be best in class at what it does.

Please submit your final Business Model Canvas project here by Thursday, Oct 25th, 11pm EDT. I will pick out a bunch that I like and review them next week on office hours.

That will be the final event in this course. I hope you have enjoyed this class/series. I think sustainability is an important and overlooked aspect of business and it needs to built more tightly into business thinking.

I will be doing office hours today at 6pm eastern. You can watch them here on this link. If you want to submit questions for office hours, you can do that here. Just like last week, I will review a few business model canvas projects and then will answer questions for the rest of the office hours.

This week I'd like to talk about company culture and how it impacts sustainability. If you want to be in business forever, you need to build a culture that sustains the business. I talked a lot about this in a post on culture a while back. You should give that a read as part of the assigned reading for this course. Here is the money quote from that post:

Companies are not people. But they are comprised of people. And the people side of the business is harder and way more complicated than building a product is. You have to start with culture, values, and a committment to creating a fantastic workplace. You can't fake these things. They have to come from the top. They are not bullshit. They are everything. There will be things that happen in the course of building a business that will challenge the belief in the leadership and the future of the company. If everyone is a mercenary and there is no shared culture and values, the team will blow apart. But if there is a meaningful culture that the entire team buys into, the team will stick together, double down, and get through those challenging situations.

I thought to myself that the mistake the CEO of that company made was bringing the mercenaries and doubters into the company in the first place and allowing them to stay.

Mercenaries have no place in your company and your culture. Doubters are a bit different. You certainly don't want to create a culture of "yes maam" in your company. So some doubting is healthy. But it should be out in the open. The doubts should be expressed upfront and they should be discussed and debated. But once the decisions have been made, everyone needs to get behind them. Ongoing doubting is not helpful to a culture.

True believers are required to get through the hard parts. And you need to be the leader who inspires the true believers. Watch this short video where @dens described what he did when Facebook launched a competing product to Foursquare.

You get true believers in your company by giving them something to believe in and someone to believe in. That is you. Even if you are scared shitless or bummed out, you can't show that to the team. You have to lead if you want the team to follow.

The thing that you give them to believe in is called a vision. Make it a long one, a very long one. I like Bill Gates' vision for Microsoft:

When Paul Allen and I started Microsoft over 30 years ago, we had big dreams about software,” recalls Gates. “We had dreams about the impact it could have. We talked about a computer on every desk and in every home.

A computer on every desk and in every home. That was a big hairy audacious goal in the late 70s. And it is exactly what happened, at least in the developed world.

The cool thing about that vision is it is drop dead simple to understand but took decades to execute. That's a long vision that your team can buy into and stick with for the long haul. That's what you need.

So if you want to build a business that lasts, you need a big and long vision and you need to be a leader who can inspire the team to believe in the vision and to believe in you. You need to hire folks who will stick around for the long haul and you need to be open to the doubts and doubters. But if they keep doubting, you need to part company with them. Don't hire mercanaries. They won't work no matter how hard you try.

Building a culture that can sustain the business is the most important investment you can make in your company. Once you've gotten a product into the market and proven product market fit, there is nothing that is more important than team, culture, and values. It is the glue that holds the whole thing together for the long haul.

Office hours will take place at 6pm eastern today. The link to the hangout is here. I don't like the way office hours worked last week and so I am changing them up. I will start by asking people to post questions in this discussions section. Then I will review a few business model canvas projects live for everyone to see. Then I'll finish up the 30 minute session by answering as many questions as possible while time lasts.

There are roughly 80 business model canvas projects posted so far. You can see them here. Since I will only be able to review a few of them today in office hours, it would be great for anyone who is taking this class to stop by and pick a few to give comments on.

If you are looking for a web-based tool to build and share your business model canvas, this thread mentions several of them.

OK. Now that we are done with the logistics, I will move on to my second post in this series.

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Last week we talked about long term thinking vs short term thinking. But sometimes, no matter how long term you are thinking, things happen that you didn't plan for and they can impact your business. Actually, this always happens. And that is when you need to adapt.

You will not stay in business forever if you don't adapt to changing market conditions. This doesn't mean adopting the "business model of the hour" model and this doesn't mean pivoting either. What I am talking about is the once every few years "oh shit moment" when you realize that the path you are on isn't going to work in a year or two and that you need to make some changes.

This is a frustrating realization. I have a good friend who has been running a business for more than a decade. He told me a few weeks ago that he thinks the market he has been operating in is changing and it is starting to impact his business. And just when he had everything firing on all cylinders.

That's how it is in business. Just as you are taking the victory lap for the kickass execution you and the team have delivered, the track takes a tilt and things start getting harder. Businesses don't operate in a vacuum. They operate in a dynamic ever changing market that is going to make things difficult for you, especially if you want to be in business forever.

I think some examples will help. The one that comes to mind front and center is Microsoft. By the middle of the 1990s, Microsoft had it all. They had a dominant share in desktop operating systems and a dominant share in desktop apps. They were literally printing money. Then the commerical internet happened. Netscape showed up. And Microsoft's market changed, forever.

Microsoft did adapt. They built Internet Explorer in reaction to Netscape and then used their desktop dominance to push it into the market, hurting Netscape so badly that it had to sell to AOL. That got Microsoft into trouble with the Justice Department and they were investigated as a result.

But what Microsoft didn't see in 1995 was Google because it didn't exist. And they didn't see the emergence of cloud based productivity apps because they didn't exist. In hindsight, it is pretty easy to see how fundamentally transformed Microsoft's business has been by the Internet and it is also pretty easy to see that they have not been able to adapt sufficiently to maintain any semblance of the dominance they had in the mid 90s. This stock chart tells you everything you need to know about what the Internet did to Microsoft. They may be surviving but they are certainly not thriving.

Another great example is RIM. I don't even need to tell this story. Everyone knows that the dismissive tone and stance that RIM's management took toward the iPhone and what it represented was essentially the death knell of a great company. I suspect they wish their stock chart looked like Microsoft's.

But let's look at a more positive example. As Ron Ashkenas points out in this HBR article, IBM saw that the hardware market was changing and their competitive position in it was changing with it. They sold their PC hardware business in 2005 to Lenovo and doubled down on consulting and related services. Their stock chart tells the rest of this story.

Adapting doesn't always mean exiting a business that you decide has issues. You can also retool, reshape, and refocus the business. A company that I've worked with for more than a decade saw the industry it services go through some painful transitions in the 2008/2009 downturn. They built an entirely new line of products that service the growth part of the industry while working to maintain the older products through an orderly and gradual decline. It's been a difficult transition because it has meant that the company's top line hasn't grown during this transition. But the company is still in business and the new products are growing quite nicely.

Every situation is different and I don't have some "silver bullet" to help you all think about how to figure out when to adapt and when to stay the course. But I do have some observations. The comfort of a strong balance sheet (and a nice looking stock chart) is often your enemy not your friend in these situations. The most agressive CEOs I've seen in these situations are often the ones with less than a year of cash in the bank and survival instinct in full on mode.

Another observation is that getting your organization to adapt is harder than you might think. Organizations have inertia. The bigger they are the more inertia they have. If you think you need to adapt your business quickly, you will need to figure who is in the boat with you and who is not and make the changes you need, particularly on your senior team, to align the team with mission and get going.

Finally, you cannot be in adaptation mode all the time. If you map out long living successful businesses, you will see they go through periods of great stability followed by periods of great change and then move back into stability mode. You have to know when to get into which mode and you need to see each one through to its logical conclusion.

Given how hard all of this is, you might wonder if you really want to stay in business forever. The answer may be no. But even if it is no, you had better plan for and act like you do. Because I am certain that if you don't, you won't.

To join today's Office Hours on Google Hangouts, please check out the Skillshare page. There will be instructions there later today. [update: you can access the office hours hangout when its live here or afterwards via an archive here]

I will start with a post on Short Term Profit Maximization vs Long Term Business Health and then will end with some comments on our Business Model Canvas project.

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If you want to stay in business forever, you have to focus on the long term. You must construct a business model that builds confidence and trust with your customers and keeps them coming back day after day, year after year.

Many business schools teach executives and entrepreneurs that business is about profit maximization. I don't believe that. I believe business is about making a profit that sustains the business and enriches the owners but is not maximized in any period (month, quarter, year). I believe the goal of a business is sustainability so that all the stakeholders (customers, employees, owners, suppliers, etc) can rely on the business for the long term.

Let's use an example. You own a business that operates on the web. You are a leading supplier of ecommerce to a vertical market. You generate $50mm in annual revenues and make a profit of $5mm a year. You see the launch of the iPhone and Android and think that your customers are going to want to connect to your business via their mobile phones. You ask your VP Product to scope out what it would take to build a comprehensive set of mobile apps that will allow this. She tells you it will take an investment of $5mm over two years to complete this project. You gulp. That is going to reduce your profits by $2.5mm a year in each of the next two years. What do you do? You make the investment because you must invest in the long term success of the business even though that is not a profit maximizing event. It may simply get you back to the $5mm per year of profits you were making before. There may be no ROI on this investment in a positive sense. It may simply be a defensive investment. You still need to make it to ensure you will be around for the long run.

Clay Christensen talks about this kind of thing all the time. Big company executives are asked to calculate an return on investment (ROI) on the investments they want to make. If the ROI isn't greater than some minimum hurdle, the company doesn't make the investment. And so along comes a smaller competitor who makes the investment and they eat the big company's lunch.

ROI is not the right framework for companies to evaluate investments. ROI is for the wall street folks. They will use it to decide if they want to invest in your company. But when you make investment decisions in your company, don't use the tools that wall street uses. Use the tools that animals use. Survival instincts. What will it take to ensure that your company is around in ten years, fifty years, 100 years? That's how to think if you want to stay in business.

One of the most difficult decisions entrepreneurs and executives have to make is the decision to disrupt their own business. Let's say you are a cable operator. You are making billions of dollars of profits each year providing voice, video, and data services protected by a monopoly business model. Along comes the Internet and it allows voice and video to be delivered to your customers via any IP network (wireline, cable, wireless, etc). You know that over time, this is going to disrupt your business. What do you do? Do you invest in this new technology and drive it into the market, hastening the decline of your monopoly protected business model or do you do everything you can to slow down the advance of this technology?

Sadly most executives make the latter choice. Most entrepreneurs make the former choice. The latter choice is about short term profit maximation but can, and often does, lead to the demise of the business in the long term. The latter choice is about survivability even though it will almost surely lead to a less profitable business in the future. Tough choice. But to me its an easy choice if your goal is long term survival.

One of the reasons entrepreneurs make these hard choices when executives don't is entrepreneurs think like owners. They have that survival instinct in their gut. They don't want their baby to die. Executives are hired guns. They are focused on maximing the success of the business (and their compensation) over a short period that they will in the corner office. They have no incentive to think about what happens in 20 years or 50 years. They know they won't be around. And so the company isn't around either.

So when you construct your business model and create the culture of your business, emphasize sustainability over profit maximization in everything you create and do. This does not mean that you don't need to make a profit. Profits are the essence of survivability. You can't and won't survive without profits. They are everything when it comes to sustainability. But just because you need to make a profit doesn't mean you need to maximize it. Balancing the need for a profit with the need to sustain the business is the art of what you must do as the leader of a business. Do both and you win.

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Our project in this course is to create a sustainable business model canvas. If you are not familiar with the Business Model Canvas watch this video:

You will either have a business or you will invent a business and then you will map out your Business Model Canvas with the goal of sustainability as you go. You can do this by yourself or in teams. It doesn't matter at all. The goal is to do this project and learn by doing.

The thing I want you to focus on the most is the decisions you make as you fill out the canvas and which ones you were forced to compromise on some goal in order to maximize the sustainability of the business. Those are the magic decisions and the ones we want to document and discuss as we go through this course.

Good luck. Hopefully I will see you at 6pm eastern today in Google Hangouts.